**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

 
| **x**                                                                                                                                                                                                                         | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934.** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                          |
| **For the quarterly period ended September 30,  2007.**                                                                                                                                                                       |
|                                                                                                                                                                                                                          |
| **OR**                                                                                                                                                                                                                        |
|                                                                                                                                                                                                                          |
| **o**                                                                                                                                                                                                                         | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.** |
|                                                                                                                                                                                                                          |
| **For the  transition period from                    to              ** |
|                                                                                                                                                                                                                          |

 

**CommissionFile Number:****1-11388**

 

**PLC SYSTEMS INC.**

(Exact Name ofRegistrant as Specified in Its Charter)

 

| **Yukon Territory, Canada**                | ** ** | **04-3153858**                       |
|--------------------------------------------|------------|--------------------------------------|
| (State or Other Jurisdiction of            | * *   | (I.R.S. Employer Identification No.) |
| Incorporation or Organization)             |       |                                 |
|                                       |       |                                 |
| **10 Forge Park, Franklin, Massachusetts** | ** ** | **02038**                            |
| (Address of Principal Executive Offices)   | * *   | (Zip Code)                           |

 

 

Registrant’stelephone number, including area code: **(508) 541-8800**

 

Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes  x  No o

 

Indicate by check mark whether theregistrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer.  See definition of“accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  (Check one):

Large acceleratedfiler o                      Acceleratedfiler o                    Non-acceleratedfiler x

 

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct)  Yes  o   No x

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

| **Class**                  |   | **Outstanding at November 7, 2007** |
|----------------------------|--------|-------------------------------------|
| Common Stock, no par value |   | 30,324,913                          |

 

 

 

----

 

**PLCSYSTEMS INC.**

 

**Index**

 

 
| Part I.  | Financial Information: |                                                                                        |
|----------|------------------------|---------------------------------------------------------------------------------------------|
|     |                   |                                                                                        |   |
|     | Item 1.                | Financial Statements                                                                        |   |
|     |                   |                                                                                        |   |
|     |                   | Condensed Consolidated Balance Sheets  (unaudited)                                          |   |
|     |                   |                                                                                        |   |
|     |                   | Condensed Consolidated Statements of  Operations (unaudited)                                |   |
|     |                   |                                                                                        |   |
|     |                   | Condensed Consolidated Statements of Cash Flows  (unaudited)                                |   |
|     |                   |                                                                                        |   |
|     |                   | Notes to  Condensed Consolidated Financial Statements (unaudited)                           |   |
|     |                   |                                                                                        |   |
|     | Item 2.                | Management’s  Discussion and Analysis ofFinancial  Condition and Results of Operations |   |
|     |                   |                                                                                        |   |
|     | Item 3.                | Quantitative  and Qualitative Disclosures about Market Risk                                 |   |
|     |                   |                                                                                        |   |
|     | Item 4.                | Controls and  Procedures                                                                    |   |
|     |                   |                                                                                        |   |
| Part II. | Other Information:     |                                                                                        |
|     |                   |                                                                                        |   |
|     | Item 1A.               | Risk Factors                                                                                |   |
|     |                   |                                                                                        |   |
|     | Item 6.                | Exhibits                                                                                    |   |
|          |                        |                                                                                             |  |  |

 

2

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**Part I.         Financial Information**

 

**Item 1.        Financial Statements**

 

**PLCSYSTEMS INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(Inthousands)**

**(Unaudited)**

 
| ** **                                                                                                                                                              | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|------------------------|------------|
| **ASSETS**                                                                                                                                                              | ** ** | ** **              | ** ** | ** **             | ** ** |
| Current assets:                                                                                                                                                         |       |                    |       |                   |       |
| Cash and cash  equivalents                                                                                                                                              |       | $                       | 8,712      |                   | $          | 6,034 |   |
| Short-term  investments                                                                                                                                                 |       | —                  |       | 4,000                  |       |
| Accounts  receivable, net of allowance of $26 and $51 at September 30, 2007 and  December 31, 2006, respectively                                              |       | 1,218                   |       | 918                    |       |
| Inventories, net                                                                                                                                                        |       | 855                     |       | 1,255                  |       |
| Prepaid expenses  and other current assets                                                                                                                              |       | 718                     |       | 595                    |       |
| Total current  assets                                                                                                                                                   |       | 11,503                  |       | 12,802                 |       |
| Equipment,  furniture and leasehold improvements, net                                                                                                                   |       | 253                     |       | 166                    |       |
| Other assets                                                                                                                                                            |       | 199                     |       | 208                    |       |
| Total assets                                                                                                                                                            |       | $                       | 11,955     |                   | $          | 13,176 |   |
|                                                                                                                                                                    |       |                    |       |                   |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                           |       |                    |       |                   |       |
| Current  liabilities:                                                                                                                                                   |       |                    |       |                   |       |
| Accounts payable                                                                                                                                                        |       | $                       | 471        |                   | $          | 456 |   |
| Accrued  compensation                                                                                                                                                   |       | 782                     |       | 396                    |       |
| Accrued other                                                                                                                                                           |       | 274                     |       | 317                    |       |
| Deferred revenue                                                                                                                                                        |       | 2,290                   |       | 1,784                  |       |
| Total current  liabilities                                                                                                                                              |       | 3,817                   |       | 2,953                  |       |
| Deferred revenue                                                                                                                                                        |       | 2,419                   |       | 3,094                  |       |
| Commitments and  contingencies                                                                                                                                          |       |                    |       |                   |       |
| Stockholders’  equity:                                                                                                                                             |       |                    |       |                   |       |
| Preferred stock,  no par value, unlimited shares authorized, none issued and outstanding                                                                                |       | —                  |       | —                 |       |
| Common stock, no  par value, unlimited shares authorized, 30,325 and 30,311 shares issued and  outstanding as of September 30, 2007 and December 31, 2006, respectively |       | 93,889                  |       | 93,882                 |       |
| Additional paid  in capital                                                                                                                                             |       | 220                     |       | 101                    |       |
| Accumulated  deficit                                                                                                                                                    |       | (88,079                 | )          | (86,531                | )          |
| Accumulated  other comprehensive loss                                                                                                                                   |       | (311                    | )          | (323                   | )          |
| Total  stockholders’ equity                                                                                                                                        |       | 5,719                   |       | 7,129                  |       |
| Total  liabilities and stockholders’ equity                                                                                                                        |       | $                       | 11,955     |                   | $          | 13,176 |   |

 

 

The accompanyingnotes are an integral part of the condensed consolidated financial statements.

 

3

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**PLCSYSTEMS INC.**

**CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Inthousands, except per share data)**

**(Unaudited)**

 
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|---------------------------------------|------------|--------------------------------------|------------|
| ** **                                | ** ** | **2007**                              | ** ** | **2006**                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Revenues:                                 |       |                                  |       |                                 |       |   |   |   |   |
| Product sales                             |       | $                                     | 975        |                                 | $          | 1,205 |   | $ | 3,629 |   | $ | 4,262 |   |
| Service fees                              |       | 356                                   |       | 362                                  |       | 1,127 |   | 1,137 |   |
| Total revenues                            |       | 1,331                                 |       | 1,567                                |       | 4,756 |   | 5,399 |   |
| Cost of  revenues:                        |       |                                  |       |                                 |       |   |   |   |   |
| Product sales                             |       | 258                                   |       | 422                                  |       | 1,406 |   | 1,487 |   |
| Service fees                              |       | 210                                   |       | 168                                  |       | 631 |   | 516 |   |
| Total cost of  revenues                   |       | 468                                   |       | 590                                  |       | 2,037 |   | 2,003 |   |
| Gross profit                              |       | 863                                   |       | 977                                  |       | 2,719 |   | 3,396 |   |
| Operating  expenses:                      |       |                                  |       |                                 |       |   |   |   |   |
| Selling, general  and administrative      |       | 830                                   |       | 786                                  |       | 2,919 |   | 2,470 |   |
| Research and  development                 |       | 637                                   |       | 394                                  |       | 1,684 |   | 1,385 |   |
| Total operating  expenses                 |       | 1,467                                 |       | 1,180                                |       | 4,603 |   | 3,855 |   |
| Gain on the sale  of manufacturing rights |       | —                                |       | —                               |       | — |   | 1,432 |   |
| Income (loss)  from operations            |       | (604                                  | )          | (203                                 | )          | (1,884 | ) | 973 |   |
| Other income,  net                        |       | 105                                   |       | 123                                  |       | 336 |   | 310 |   |
| Net income  (loss)                        |       | $                                     | (499       | )                                    | $          | (80 | ) | $ | (1,548 | ) | $ | 1,283 |   |
| Basic income  (loss) per share            |       | $                                     | (0.02      | )                                    | $          | (0.00 | ) | $ | (0.05 | ) | $ | 0.04 |   |
| Diluted income  (loss) per share          |       | $                                     | (0.02      | )                                    | $          | (0.00 | ) | $ | (0.05 | ) | $ | 0.04 |   |
| Average shares  outstanding:              |       |                                  |       |                                 |       |   |   |   |   |
| Basic                                     |       | 30,323                                |       | 30,237                               |       | 30,315 |   | 30,080 |   |
| Diluted                                   |       | 30,323                                |       | 30,237                               |       | 30,315 |   | 30,518 |   |

 

 

The accompanying notesare an integral part of the condensed consolidated financial statements.

 

4

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**PLC SYSTEMS INC.**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(In thousands)**

**(Unaudited)**

 
| ** **                                                                                           | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                           | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| Operating  activities:                                                                               |       |                                 |       |   |   |
| Net income  (loss)                                                                                   |       | $                                    | (1,548     | ) | $ | 1,283 |   |
|                                                                                                 |       |                                 |       |   |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used for) operating activities: |       |                                 |       |   |   |
| Depreciation and  amortization                                                                       |       | 75                                   |       | 87 |   |
| Compensation  expense from stock options                                                             |       | 119                                  |       | 68 |   |
| Loss on  retirement of equipment                                                                     |       | —                               |       | 77 |   |
| Change in assets  and liabilities:                                                                   |       |                                 |       |   |   |
| Accounts  receivable                                                                                 |       | (300                                 | )          | (248 | ) |
| Inventory                                                                                            |       | 400                                  |       | (201 | ) |
| Prepaid expenses  and other assets                                                                   |       | (123                                 | )          | 84 |   |
| Accounts payable                                                                                     |       | 15                                   |       | 51 |   |
| Deferred revenue                                                                                     |       | (172                                 | )          | (410 | ) |
| Accrued  liabilities                                                                                 |       | 343                                  |       | (61 | ) |
| Net cash  provided by (used for) operating activities                                                |       | (1,191                               | )          | 730 |   |
|                                                                                                 |       |                                 |       |   |   |
| Investing  activities:                                                                               |       |                                 |       |   |   |
| Purchase of  investments                                                                             |       | —                               |       | (4,000 | ) |
| Maturity of  investments                                                                             |       | 4,000                                |       | 5,400 |   |
| Purchase of  equipment                                                                               |       | (153                                 | )          | (69 | ) |
| Net cash  provided by investing activities                                                           |       | 3,847                                |       | 1,331 |   |
|                                                                                                 |       |                                 |       |   |   |
| Financing  activities:                                                                               |       |                                 |       |   |   |
| Net proceeds  from exercise of stock options                                                         |       | 6                                    |       | 107 |   |
| Net proceeds  from issuance of common stock                                                          |       | 1                                    |       | 1 |   |
| Net cash  provided by financing activities                                                           |       | 7                                    |       | 108 |   |
|                                                                                                 |       |                                 |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                                        |       | 15                                   |       | 15 |   |
| Net increase in  cash and cash equivalents                                                           |       | 2,678                                |       | 2,184 |   |
| Cash and cash  equivalents at beginning of period                                                    |       | 6,034                                |       | 2,560 |   |
| Cash and cash  equivalents at end of period                                                          |       | $                                    | 8,712      |   | $ | 4,744 |   |

 

 

The accompanying notesare an integral part of the condensed consolidated financial statements.

 

5

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**PLCSYSTEMS INC.**

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

September 30, 2007

 

***1.***             ***Natureof Business***

 

PLC Systems Inc. (“PLC” or the “Company”) is a medicaldevice company specializing in innovative technologies for the cardiac andvascular markets. The Company pioneered and manufactures the *CO**2** Heart Laser System* (the “Heart Laser System”) that cardiacsurgeons use to perform carbon dioxide (CO2) transmyocardial revascularization, orTMR, to alleviate symptoms of severe angina. In addition, the Company hascommenced clinical trials for the Company’s RenalGuard TherapyTMandRenalGuard SystemTM (collectively “RenalGuard”). RenalGuard Therapy is designedto reduce the toxic effects that contrast media can have on the kidneys. Thistherapy is based on the theory that creating and maintaining a high urineoutput is beneficial to patients undergoing cardiovascular imaging procedureswhere contrast agents are used. The real-time measurement and matched fluidreplacement design of the Company’s RenalGuard System is intended to ensurethat a high urine flow is maintained before, during and after these procedures,thus allowing the body to rapidly eliminate contrast, reducing its toxiceffects. The RenalGuard System, with its matched fluid replacement capability,is intended to minimize the risk of over- or under-hydration.

 

In December2006, the Company received full FDA approval to conduct its first humanclinical trial utilizing RenalGuard under an investigational device exemption.This 40-patient pilot clinical trial is designed to evaluate the safety of theRenalGuard System and its ability to accurately measure and balance fluidinputs and outputs on patients undergoing a catheterization imaging procedurewhere contrast media will be administered.

 

The Companyhopes to be able to demonstrate through future clinical trials that RenalGuardis also safe and effective in preventing Contrast-Induced Nephropathy (“CIN”),a form of acute renal failure caused by exposure to contrast media for certainpatients undergoing imaging procedures.

 

On March 20, 2007, the Company entered into adistribution agreement with Novadaq Corp. (“Novadaq”), a subsidiary of NovadaqTechnologies Inc., pursuant to which the Company appointed Novadaq as itsexclusive distributor in the United States for the TMR business. This agreementamended and restated the exclusive distribution agreement between the Companyand Edwards Lifesciences LLC (“Edwards”), which was assigned by Edwards toNovadaq on the same date. The agreement with Novadaq reflects substantially thesame roles, responsibilities and financial terms as the Company’s previousagreement with Edwards.

 

***2.******                                     ******Basis of Presentation***

 

Theaccompanying unaudited condensed consolidated financial statements of theCompany have been prepared in accordance with generally accepted accountingprinciples for interim financial information and with the instructions to Form10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotesrequired by generally accepted accounting principles for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring adjustments)considered necessary for a fair presentation have been included.  Operating results for the three and ninemonths ended 

 

6

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September30, 2007 are not necessarily indicative of the results that may be expected forthe year ending December 31, 2007.  Thesefinancial statements should be read in conjunction with the consolidatedfinancial statements and footnotes thereto included in the Company’s AnnualReport on Form 10-K for the year ended December 31, 2006.

 

***3.******                                     ******NewAccounting Pronouncement***

 

In June 2006, the FinancialAccounting Standards Board (“FASB”) issued Interpretation No. 48, “Accountingfor Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN48”).  This statement clarifies thecriteria that an individual tax position must satisfy for some or all of thebenefits of that position to be recognized in a company’s financialstatements.  FIN 48 prescribes arecognition threshold of more-likely-than-not, and a measurement attribute forall tax positions taken or expected to be taken on a tax return, in order forthose tax positions to be recognized in the financial statements.

 

Effective January 1, 2007,the Company has adopted the provisions of FIN 48. The adoption of FIN 48 didnot have an impact on the Company’s consolidated financial statements.Effective with the adoption of FIN 48, the Company recognizes interest and penalties relatedto uncertain tax positions as a component of the provision for income taxes.

 

As of January 1, 2007, theCompany had deferred tax assets of $51 million, primarily comprised of federaland state tax net operating loss carryforwards and federal and state researchand development credit carryforwards. Under the Internal Revenue Code, certainsubstantial changes in the Company’s ownership may limit the amount of netoperating loss carryforwards that can be utilized in any one year to offsetfuture taxable income. Any carryforwards that will expire prior to utilizationas the result of any limitations will be removed from deferred tax assets witha corresponding reduction of the valuation allowance. Due to theexistence of the valuation allowance, future changes in the Company’sunrecognized tax benefits will not impact its effective tax rate.

 

The Company maintained areserve of $70,000 as of September 30, 2007 for any potential tax matters thatcould arise in the future.  The reservedid not change during the nine months ended September 30, 2007.

 

The Company files income taxreturns in the U.S. federal jurisdiction and in several state and foreignjurisdictions. For U.S. federal and state tax purposes, the tax years 2003through 2006 remain open to examination. In addition, the amount of the Company’s federal and state net operatingloss carryforwards may be subject to examination and adjustment. Theexamination periods for the Company’s foreign jurisdictions range from 1997through 2006.

 

***4.******                                     ******Inventories***

 

Inventories are stated at the lower of cost(computed on a first-in, first-out method) or market value and includeallocations of labor and overhead.  As ofSeptember 30, 2007 and December 31, 2006, inventories consisted of thefollowing (in thousands):

 

7

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| ** **       | ** ** | **September 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|------------------|------------|-------------------------|------------|------------------------|------------|
| Raw materials    |       | $                       | 610        |                   | $          | 791 |   |
| Work in progress |       | 98                      |       | 118                    |       |
| Finished goods   |       | 147                     |       | 346                    |       |
|             |       | $                       | 855        |                   | $          | 1,255 |   |

 

At September 30, 2007 and December 31, 2006,inventories are stated net of a specific obsolescence allowance of $507,000 and$548,000, respectively.

 

***5.******                                     ******Stock-BasedCompensation***

 

*Stock Option and Stock Purchase Plans*

 

In May 2005,the Company adopted the 2005 Stock Incentive Plan (the “2005 Plan”).  The 2005 Plan replaced the 1997 ExecutiveStock Option Plan, 2000 Equity Incentive Plan, 2000 Non-Statutory Stock OptionPlan and 2000 Non-Qualified Performance and Retention Equity Plan (collectively,the “Previous Plans”), under which no further awards can be granted.

 

The number of stock optionsthat may be granted under the 2005 Plan is equal to 2,156,175 shares of commonstock (subject to adjustment in the event of stock splits and other similarevents), plus such number of shares as may become available under the PreviousPlans after the date of the adoption of the 2005 Plan because any awardpreviously granted under any such plan expires or is terminated, surrendered orcancelled without having been fully exercised or is forfeited in whole or inpart or results in any common stock not being issued, provided that such numberof additional shares may not exceed 2,535,492. Incentive stock options are issuable only to employees of the Company,while non-qualified options may be issued to non-employee directors,consultants, and others, as well as to employees. The options granted under thePrevious Plans and the 2005 Plan become exercisable either immediately, orratably over one to four years from the date of grant, and expire ten yearsfrom the date of grant.  The per shareexercise price of incentive stock options may not be less than the fair marketvalue of the common stock on the date the option is granted.

 

The Company grants stockoptions to its non-employee directors. Generally, new non-employee directorsreceive an initial grant of an option to purchase 30,000 shares of the Company’scommon stock that vests in installments over three years.  Once the initial grant has fully vested,non-employee directors other than the Chairman of the Board receive an annualgrant of an option to purchase 15,000 shares of the Company’s common stock thatgenerally vests in four equal quarterly installments. The Chairman of the Boardreceives an annual grant of an option to purchase 30,000 shares of the Company’scommon stock that generally vests in four equal quarterly installments in thesame manner as the options granted annually to the other non-employeedirectors. All such options have an exercise price equal to the fair marketvalue of the common stock on the date of grant.

 

Options granted during 2007and 2006 will vest ratably annually over a three year period for employees andratably quarterly over a one year period for non-employee directors.

 

8

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The following is a summary of option activity under all plans (inthousands, except per option data):

 

| ** **                       | ** ** | **Number   of   Options** | ** ** | **Weighted   Average   Exercise  Price** | ** ** | **Average   Remaining   Contractual   Life (Years)** | ** ** |
|----------------------------------|------------|---------------------------|------------|------------------------------------------|------------|------------------------------------------------------|------------|
| Outstanding,  December 31, 2006  |       | 4,767                     |       | $                                        | 1.05       |                                                 |       |   |
| Granted                          |       | 618                       |       | 0.64                                     |       |                                                 |       |
| Exercised                        |       | (13                       | )          | 0.47                                     |       |                                                 |       |
| Forfeited                        |       | (7                        | )          | 0.75                                     |       |                                                 |       |
| Expired                          |       | (67                       | )          | 4.74                                     |       |                                                 |       |
| Outstanding,  September 30, 2007 |       | 5,298                     |       | 0.96                                     |       | 6.00                                                 |       |
| Exercisable,  September 30, 2007 |       | 4,379                     |       | 1.02                                     |       | 5.31                                                 |       |
|                                  |            |                           |            |                                          |            |                                                      |            |  |

 

The following table summarizes unvested option activity during the ninemonths ended September 30, 2007:

 

| ** **                    | ** ** | **Number  of  Options**                          | ** ** | **Weighted   Average   Grant Date   Fair Value** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                    | ** ** | **(in thousands, except weighted average data)** | ** ** |
| Unvested,  December 31, 2006  |       | 531                                              |       | $                                                | 0.51       |   |
| Granted                       |       | 618                                              |       | 0.44                                             |       |
| Vested                        |       | (227                                             | )          | 0.50                                             |       |
| Forfeited                     |       | (3                                               | )          | 0.50                                             |       |
| Unvested,  September 30, 2007 |       | 919                                              |       | 0.47                                             |       |
|                               |            |                                                  |            |                                                  |            |  |

 

*SFAS No. 123R*

 

Effective January 1, 2006, the Companyadopted the fair value recognition provisions of Statement of FinancialAccounting Standards No. 123 (revised 2004), “Share-based Payment” (“SFAS No.123R”), using the modified-prospective transition method, which did not requirerestatement of prior period results. In the three and nine months endedSeptember 30, 2007, the Company recorded compensation expense of $49,000 and$119,000, respectively, for all share-based payments granted subsequent toDecember 31, 2005, based on the grant-date fair value estimated in accordancewith the provisions of SFAS No. 123R. The Company estimates an expectedforfeiture rate based on its historical forfeiture activity.  Actual results, and future changes inestimates, may differ substantially from the Company’s current estimates.  As of September 30, 2007, the Company had$437,000 of total unrecognized compensation cost related to its unvestedoptions, which is expected to be recognized over a weighted average period of2.09 years.

 

The weighted average fairvalue of options issued during the nine months ended September 30, 2007 was estimatedusing the Black-Scholes model.

 

9

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| ** **               | ** ** | **Nine Months Ended  September 30, 2007** | ** ** |
|--------------------------|------------|-------------------------------------------|------------|
| Expected life  (years)   |       | 5.50-6.00                                 |       |
| Interest rate            |       | 4.62%-5.20%                               |       |
| Volatility               |       | 74.7%-77.4%                               |       |
| Expected  dividend yield |       | None                                      |       |
| Value of option  granted |       | $0.43-$0.45                               |       |

 

There were no options granted in the three monthsended September 30, 2007.

 

The expected lifeis calculated using the simplified method. The risk-free interest rate is basedon the U.S. Treasury yield curve in effect at the time of the grant for theexpected term period.  Expectedvolatility is based exclusively on historical volatility data of the Company’scommon stock.

 

The Company has a 2000Employee Stock Purchase Plan (the “Purchase Plan”) for all eligible employeeswhereby shares of the Company’s common stock may be purchased at six-monthintervals at 95% of the closing price of the Company’s common stock on the lastbusiness day of the relevant plan period. Employees may purchase shares having a value not exceeding 10% of theirgross compensation during an offering period, subject to certain additionallimitations. Under the Purchase Plan, employees of the Company purchased 612shares and 1,235 shares of common stock in the nine months ended September 30,2007 and the year ended December 31, 2006 at average prices of $0.64 and $0.65per share, respectively. At September 30, 2007, 320,640 shares were reservedfor future issuance under the Purchase Plan.

 

***6.******                                     ******Revenue Recognition***

 

The Company records revenuefrom the sale of TMR kits at the time of shipment to Novadaq.  TMR kit revenues include the amount invoicedto Novadaq for kits shipped pursuant to purchase orders received, as well as anamortized portion of deferred revenue related to a payment of $4,533,333received in February 2004.  This paymentwas made in exchange for a reduction in the prospective purchase price theCompany receives upon a sale of the kits. The Company is amortizing this payment into its Consolidated Statementsof Operations as revenue over a seven year period (culminating in 2010) underthe units-of-revenue method as prescribed by Emerging Issues Task Force 88-18, “Salesof Future Revenue”.  The Companydetermined that a seven year timeframe was the most appropriate amortizationperiod based on a valuation model it used to assess the economic fairness ofthe payment. Factors the Company considered in developing this valuation modelincluded the estimated foregone revenues over a seven year period resultingfrom the reduction in the prospective purchase price payable to the Company, adiscount rate deemed appropriate to this transaction and an estimate of theremaining economic useful life of the current TMR kit design, without anybenefit being given to potential future product improvements the Company maymake.  The Company reviews annually, andadjusts if necessary, the prospective revenue amortization rate for kits basedon its best estimate of the total number of kits likely remaining to be shippedto hospital customers by Novadaq through 2010. The Company recordedamortization of $132,000 and $503,000 in the three and nine months endedSeptember 30, 2007, respectively, as compared to $158,000 and $483,000 in thethree and nine months ended September 30, 2006, respectively, which is includedin revenues in the Consolidated Statements of Operations.

 

10

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TMR lasers are billed toNovadaq in accordance with purchase orders that the Company receives.  Invoiced TMR lasers are recorded as othercurrent assets and deferred revenue on the Company’s Consolidated Balance Sheetuntil such time as the laser is shipped to a hospital, at which time theCompany records revenue and cost of revenue.

 

Under the terms of the TMRdistribution agreement, once Novadaq has recovered a prescribed amount ofrevenue from a hospital for the use or purchase of a TMR laser, any additionalrevenues earned by Novadaq are shared with the Company pursuant to a formulaestablished in the distribution agreement. The Company only records its shareof such additional revenue, if any, at the time the revenue is earned.

 

The Company records revenue from the sale ofTMR kits and TMR lasers to international distributors or hospitals at the timeof shipment.

 

Revenues from service andmaintenance contracts are recognized ratably over the life of the contract.

 

Installation revenuesrelated to a TMR laser transaction are recorded as a component of service feeswhen the laser is installed.

 

***7.******                                     ******Earnings(Loss) per Share***

 

In the three and nine monthsended September 30, 2007 and the three months ended September 30, 2006, basicand diluted loss per share have been computed using only the weighted averagenumber of common shares outstanding during the period without giving effect toany potential future issuances of common stock related to stock optionprograms, since their inclusion would be antidilutive.

 

In the nine months ended September 30, 2006, basicearnings per share has been computed using only the weighted average number ofcommon shares outstanding during the period, while diluted earnings per sharewas computed using the weighted average number of common shares outstandingduring the period plus the effect of outstanding stock options using thetreasury stock method.  In calculatingdiluted earnings per share, the dilutive effect of stock options is computedusing the average market price for the respective period.

 

Forthe three months ended September 30, 2007 and 2006, 5,298,000 and 5,036,000shares, respectively, and for the nine months ended September 30, 2007 and2006, 5,298,000 and 5,036,000 shares, respectively, attributable to outstandingstock options were excluded from the calculation of diluted earnings per sharebecause the effect would have been antidilutive.  The following table sets forth thecomputation of basic and diluted earnings (loss) per share:

 

11

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| ** **                                                                                             | ** ** | **Three Months Ended  September 30,**     | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                             | ** ** | **2007**                                  | ** ** | **2006**                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                                                                                             | ** ** | **(In thousands, except per share data)** | ** ** |
| Basic:                                                                                                 | ** ** | ** **                                | ** ** |
| Net income  (loss)                                                                                     |       | $                                         | (499       | )                                    | $          | (80 | ) | $ | (1,548 | ) | $ | 1,283 |   |
|                                                                                                   |       |                                      |       |                                 |       |   |   |   |   |   |   |   |   |
| Weighted average  shares outstanding                                                                   |       | 30,323                                    |       | 30,237                               |       | 30,315 |   | 30,080 |   |
| Basic earnings  (loss) per share                                                                       |       | $                                         | (0.02      | )                                    | $          | (0.00 | ) | $ | (0.05 | ) | $ | 0.04 |   |
|                                                                                                   |       |                                      |       |                                 |       |   |   |   |   |
| Diluted:                                                                                               |       |                                      |       |                                 |       |   |   |   |   |
| Net income  (loss)                                                                                     |       | $                                         | (499       | )                                    | $          | (80 | ) | $ | (1,548 | ) | $ | 1,283 |   |
|                                                                                                   |       |                                      |       |                                 |       |   |   |   |   |
| Weighted average  shares outstanding                                                                   |       | 30,323                                    |       | 30,237                               |       | 30,315 |   | 30,080 |   |
| Assumed impact  of the exercise of outstanding dilutive stock options using the treasury  stock method |       | —                                    |       | —                               |       | — |   | 438 |   |
| Weighted average  common and common equivalent shares                                                  |       | 30,323                                    |       | 30,237                               |       | 30,315 |   | 30,518 |   |
|                                                                                                   |       |                                      |       |                                 |       |   |   |   |   |
| Diluted earnings  (loss) per share                                                                     |       | $                                         | (0.02      | )                                    | $          | (0.00 | ) | $ | (0.05 | ) | $ | 0.04 |   |

 

***8.******                                     ******ComprehensiveIncome (Loss)***

 

Total comprehensive loss for the three and nine monthperiods ended September 30, 2007 amounted to $492,000 and $1,536,000,respectively, as compared to comprehensive loss of $78,000 in the three monthsended September 30, 2006 and comprehensive income of $1,296,000 in the ninemonths ended September 30, 2006. Comprehensive income (loss) is comprised of net income (loss) plus theincrease/decrease in currency translation adjustment.

 

# ***9.****                                     **Warrantyand Preventative Maintenance Costs*

 

The Company warranties itsproducts against manufacturing defects under normal use and service during thewarranty period.  The Company obtainssimilar warranties from a majority of its suppliers, including those who supplycritical Heart Laser System components. In addition, under the terms of its TMR distribution agreement withNovadaq, the Company is able to bill Novadaq for actual warranty costs,including preventative maintenance services, up to a specified amount duringthe warranty period.

 

The Company evaluates theestimated future unrecoverable costs of warranty and preventative maintenanceservices for its installed base of lasers on a quarterly basis and adjusts itswarranty reserve accordingly.  TheCompany considers all available evidence, including historical experience andinformation obtained from supplier audits.

 

12

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                Changes in thewarranty accrual were as follows (in thousands):

 

| ** **                                                 | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                 | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| Balance,  beginning of period                              |       | $                                    | 60         |   | $ | 60 |   |
| Payments made                                              |       | —                               |       | — |   |
| Change in  liability for warranties issued during the year |       | —                               |       | — |   |
| Change in  liability for preexisting warranties            |       | —                               |       | — |   |
| Balance, end of  period                                    |       | $                                    | 60         |   | $ | 60 |   |

 

***10.          Gain on Sale ofManufacturing Rights***

 

InFebruary 2004, the Company signed an agreement with Edwards to assumedevelopment and manufacturing of the Optiwave 980 Cardiac Laser Ablation System(“Optiwave 980”) and related system disposables. In March 2006, the Company andEdwards terminated this agreement. The Company received $1,500,000 inconsideration for selling its Optiwave 980 system related disposablemanufacturing rights to Edwards.  Inconjunction with the sale, the Company wrote off certain inventory and capitalassets acquired to manufacture the Optiwave 980 disposables and recorded a netgain of $1,432,000 in its Consolidated Statement of Operations during the ninemonths ended September 30, 2006.

 

**Item 2.****                      ****Management’s Discussion andAnalysis of Financial Condition and Results of Operations**

 

This quarterly report (including certain informationincorporated herein by reference) contains forward-looking statements withinthe meaning of Section 27A of the Securities Act of 1933, as amended, andSection 21E of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”). Statements containing terms such as “believes”, “plans”, “expects”, “anticipates”,“intends”, “estimates” and similar expressions reflect uncertainty and areforward-looking statements. Forward-looking statements are based on currentplans and expectations and involve known and unknown important risks anduncertainties that could cause actual results to differ materially from thosedescribed in the forward-looking statements. Such important factors anduncertainties include, but are not limited to, those set forth below in PartII, Item 1A. Risk Factors, and elsewhere in this quarterly report.

 

# **Overview**

 

We are a medical device company specializing ininnovative technologies for the cardiac and vascular markets.  We pioneered and manufacture the Heart LaserSystem that cardiac surgeons use to perform TMR to alleviate symptoms of severeangina.  In addition, in early 2007, webegan treating patients in our pilot clinical safety trial for our RenalGuardTherapy and RenalGuard System. RenalGuard Therapy is designed to reduce thetoxic effects that contrast media can have on the kidneys.  This therapyis based on the theory that creating and maintaining a high urine output isbeneficial to patients undergoing cardiovascular imaging procedures wherecontrast agents are used.  The real-timemeasurement and matched fluid replacement design of our RenalGuard System isintended to ensure that a high urine flow is maintained before, during andafter these procedures, thus allowing the body to rapidly eliminate contrast,reducing its toxic effects. The RenalGuard 

 

13

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System,with its matched fluid replacement capability, is intended to minimize the riskof over- or under-hydration.

 

In December2006, we received full FDA approval to conduct our first human clinical trialutilizing RenalGuard under an investigational device exemption. This 40-patientpilot clinical trial is designed to evaluate the safety of the RenalGuardSystem and its ability to accurately measure and balance fluid inputs andoutputs on patients undergoing a catheterization imaging procedure wherecontrast media will be administered.

 

We hope tobe able to demonstrate through future clinical trials that RenalGuard is alsosafe and effective in preventing Contrast-Induced Nephropathy (“CIN”), a formof acute renal failure caused by exposure to contrast media for certainpatients undergoing imaging procedures.

 

Our U.S. distributor (Novadaq currently and Edwardsprior to March 20, 2007) is our largest customer, accounting for 88% and 85% ofour total revenues in the three and nine months ended September 30, 2007,respectively, and 88% of our total revenues in the year ended December 31,2006. We expect a high level of sales concentration to continue in the nearfuture with Novadaq as our largest customer now that it holds the exclusiveU.S. distribution rights for our TMR products.

 

Approximately 89% and 86% of our revenues in the threeand nine months ended September 30, 2007, respectively, and 95% in the yearended December 31, 2006, came from the sale and service of TMR lasers andrelated disposable kits.

 

Aggregate TMR kit shipments to U.S. hospitals throughNovadaq and Edwards decreased approximately 38% and 22% in the three and ninemonths ended September 30, 2007 as compared to the three and nine months endedSeptember 30, 2006, respectively. We believe the decline in third quarter TMRkit shipments was primarily the result of (1) disruptions in the effectivenessof the sales channel resulting from a new organizational sales force structurethat Novadaq implemented in the third quarter and (2) reduced marketingactivities during the quarter on the part of the Novadaq sales force, asNovadaq was forced to divert attention to solving and explaining to customers acritical inventory component supply shortage for its principal product line(the SPY® Imaging System). We believe this reduced salesactivity in the third quarter negatively impacted potential new sales of TMRkits to U.S. hospital customers.

 

We believe the decline in TMR kit shipments betweenthe respective nine month periods is due to (1) lower than normal TMR salesactivities conducted by Edwards during the first quarter of 2007, as Edwardsfocused its sales force on product lines other than TMR in anticipation ofassigning its TMR distribution rights, (2) sales channel transition issues inthe second quarter, which included the need to train the Novadaq sales force onTMR and the Heart Laser System, and (3) the aforementioned causes for thedecline in third quarter TMR kit shipments under Novadaq.

 

We believe it is likely to take at least severalquarters for Novadaq’s sales force to regain both the volume of TMR kitshipments to customers and the level of TMR revenues that the Edwards saleschannel was able to generate in 2006. As such, we believe that our fourthquarter revenues and results of operations for 2007 will likely be lower than thosein the corresponding period in 2006. The transition of distributionresponsibilities from Edwards to Novadaq also is expected to affect our revenueand operating results during future quarters in

 

14

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2008 and we will be largely dependent on the success of Novadaq’s salesand marketing efforts in the future to increase our installed base of TMRlasers and increase TMR procedure volumes and revenues in the U.S.

 

Our management reviews anumber of key performance indicators to assist in determining how to allocateresources and run our day to day operations. These indicators include (1)actual prior quarterly sales trends, (2) projected TMR laser and kit sales forthe next four quarters, as provided by our exclusive U.S. distributor in arolling twelve month sales forecast, (3) research and development progress asmeasured against internal project plan objectives, (4) budget to actualfinancial expenditure results, (5) inventory levels (both our own and ourdistributors’) and (6) short term and long term projected cash flows of thebusiness.

 

# **Critical Accounting Policies and Estimates**

 

Our financial statements are based on the application of significantaccounting policies, many of which require us to make significant estimates andassumptions (see Note 2 to the Consolidated Financial Statements included inour Annual Report on Form 10-K for the year ended December 31, 2006).  We believe that the following are some of themore material judgment areas in the application of our accounting policies thatcurrently affect our financial condition and results of operations.

# ** **

# ***Inventories***

 

Inventories are stated atthe lower of cost (computed on a first-in, first-out method) or market valueand include allocations of labor and overhead. A specific obsolescence allowance is provided for slow moving, excessand obsolete inventory based on our best estimate of the net realizable valueof inventory on hand taking into consideration factors such as (1) actualtrailing twelve month sales, (2) expected future product line demand, based inpart on sales forecast input received from our exclusive U.S. distributor, and(3) service part stocking levels which, in management’s best judgment, areadvisable to maintain in order to meet warranty, service contract and time andmaterial spare part demands. Historically, we have found our reserves to be adequate.

 

# ***AccountsReceivable***

 

Accounts receivable isstated at the amount we expect to collect from the outstanding balance.  We continuously monitor collections fromcustomers, and we maintain a provision for estimated credit losses based uponhistorical experience and any specific customer collection issues that we haveidentified.  Historically, we have notexperienced significant losses related to our accounts receivable, primarilyfrom Edwards and, more recently, Novadaq. Collateral is not generally required.If the financial condition of our customers were to deteriorate, resulting inan impairment of their ability to make payments, additional allowances may be required.

 

***Research and Development Expenses***

 

Research and developmentexpenses are expensed as incurred.

 

15

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# ***Warrantyand Preventative Maintenance Costs***

 

We warranty our productsagainst manufacturing defects under normal use and service during the warrantyperiod.  We obtain similar warrantiesfrom a majority of our suppliers, including those who supply critical HeartLaser System components.  In addition,under the terms of our TMR distribution agreement with Novadaq, we are able tobill Novadaq for actual warranty costs, including preventative maintenanceservices, up to a specified amount during the warranty period.

 

We evaluate the estimatedfuture unrecoverable costs of warranty and preventative maintenance servicesfor our installed base of lasers on a quarterly basis and adjust our warrantyreserve accordingly.  We consider allavailable evidence, including historical experience and information obtainedfrom supplier audits.

 

## ***RevenueRecognition***

 

We record revenue from thesale of TMR kits at the time of shipment to Novadaq.  TMR kit revenues include the amount invoicedto Novadaq for kits shipped pursuant to purchase orders received, as well as anamortized portion of deferred revenue related to a payment of $4,533,333received in February 2004.  This paymentwas made in exchange for a reduction in the prospective purchase price wereceive upon a sale of the kits.  We areamortizing this payment into our Consolidated Statements of Operations asrevenue over a seven year period (culminating in 2010) under theunits-of-revenue method as prescribed by Emerging Issues Task Force 88-18, “Salesof Future Revenue”.  We determined that aseven year timeframe was the most appropriate amortization period based on avaluation model we used to assess the economic fairness of the payment. Factorswe considered in developing this valuation model included the estimatedforegone revenues over a seven year period resulting from the reduction in theprospective purchase price payable to us, a discount rate deemed appropriate tothis transaction and an estimate of the remaining economic useful life of thecurrent TMR kit design, without any benefit being given to potential futureproduct improvements we may make. We review annually, and adjust if necessary,the prospective revenue amortization rate for kits based on our best estimateof the total number of kits likely remaining to be shipped to hospitalcustomers by Novadaq through 2010. We recorded amortization of $132,000 and$503,000 in the three and nine months ended September 30, 2007, respectively,as compared to $158,000 and $483,000 in the three and nine months endedSeptember 30, 2006, respectively, which is included in revenues in ourConsolidated Statements of Operations.

 

TMR lasers are billed toNovadaq in accordance with purchase orders that we receive.  Invoiced TMR lasers are recorded as othercurrent assets and deferred revenue on our Consolidated Balance Sheet untilsuch time as the laser is shipped to a hospital, at which time we recordrevenue and cost of revenue.

 

Under the terms of the TMRdistribution agreement, once Novadaq has recovered a prescribed amount ofrevenue from a hospital for the use or purchase of a TMR laser, any additionalrevenues earned by Novadaq are shared with us pursuant to a formula establishedin the distribution agreement. We only record our share of such additionalrevenue, if any, at the time the revenue is earned.

 

16

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We record revenue from the sale of TMR kitsand TMR lasers to international distributors or hospitals at the time ofshipment.

 

Revenues from service andmaintenance contracts are recognized ratably over the life of the contract.

 

Installation revenuesrelated to a TMR laser transaction are recorded as a component of service feeswhen the laser is installed.

## ** **

## **Resultsof Operations**

 

Results for the three and nine months endedSeptember 30, 2007 and 2006 and the related percent of revenues were asfollows:

 

 
| ** **                             | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **September 30,**          | ** ** | **September 30,**     | ** ** |
| ** **                             | ** ** | **2007**                   | ** ** | **2006**              | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                             | ** ** | **$**                      | ** ** | **%**                 | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                             | ** ** | **(dollars in thousands)** | ** ** |
|                                   |       |                       |       |                  |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total revenues                         |       | 1,331                      |       | 100                   |       | 1,567 |   | 100 |   | 4,756 |   | 100 |   | 5,399 |   | 100 |   |
| Total cost of  revenues                |       | 468                        |       | 35                    |       | 590 |   | 38 |   | 2,037 |   | 43 |   | 2,003 |   | 37 |   |
| Gross profit                           |       | 863                        |       | 65                    |       | 977 |   | 62 |   | 2,719 |   | 57 |   | 3,396 |   | 63 |   |
| Selling, general  & administrative |       | 830                        |       | 62                    |       | 786 |   | 50 |   | 2,919 |   | 62 |   | 2,470 |   | 46 |   |
| Research &  development            |       | 637                        |       | 48                    |       | 394 |   | 25 |   | 1,684 |   | 35 |   | 1,385 |   | 26 |   |
| Total operating  expenses              |       | 1,467                      |       | 110                   |       | 1,180 |   | 75 |   | 4,603 |   | 97 |   | 3,855 |   | 71 |   |
| Gain on sale of  manufacturing rights  |       | —                     |       | —                |       | — |   | — |   | — |   | — |   | 1,432 |   | 27 |   |
| Income (loss)  from operations         |       | (604                       | )          | (45                   | )          | (203 | ) | (13 | ) | (1,884 | ) | (40 | ) | 973 |   | 18 |   |
| Other income                           |       | 105                        |       | 8                     |       | 123 |   | 8 |   | 336 |   | 7 |   | 310 |   | 6 |   |
| Net income  (loss)                     |       | (499                       | )          | (37                   | )          | (80 | ) | (5 | ) | (1,548 | ) | (33 | ) | 1,283 |   | 24 |   |

 

17

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| ** **                                      | ** ** | **Three Months Ended September 30,** | ** ** | **Increase (decrease)** | ** ** | **Nine Months Ended September 30,** | ** ** | **Increase (decrease)** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|-------------------------|------------|-------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **2007**                             | ** ** | **2006**                | ** ** | **over 2006**                       | ** ** | **2007**                | ** ** | **2006** | ** ** | **over 2006** | ** ** |
| ** **                                      | ** ** | **$**                                | ** ** | **$**                   | ** ** | **$**                               | ** ** | **%**                   | ** ** | **$** | ** ** | **$** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                      | ** ** | **(dollars in thousands)**           | ** ** |
|                                            |       |                                 |       |                    |       |                                |       |                    |       |   |   |   |   |   |   |   |   |
| Product sales                                   |       | 975                                  |       | 1,205                   |       | (230                                | )          | (19                     | )          | 3,629 |   | 4,262 |   | (633 | ) | (15 | ) |
| Service fees                                    |       | 356                                  |       | 362                     |       | (6                                  | )          | (2                      | )          | 1,127 |   | 1,137 |   | (10 | ) | (1 | ) |
| Total revenues                                  |       | 1,331                                |       | 1,567                   |       | (236                                | )          | (15                     | )          | 4,756 |   | 5,399 |   | (643 | ) | (12 | ) |
| Product cost of  sales                          |       | 258                                  |       | 422                     |       | (164                                | )          | (39                     | )          | 1,406 |   | 1,487 |   | (81 | ) | (5 | ) |
| Service fees  cost of sales                     |       | 210                                  |       | 168                     |       | 42                                  |       | 25                      |       | 631 |   | 516 |   | 115 |   | 22 |   |
| Total cost of  revenues                         |       | 468                                  |       | 590                     |       | (122                                | )          | (21                     | )          | 2,037 |   | 2,003 |   | 34 |   | 2 |   |
| Gross profit                                    |       | 863                                  |       | 977                     |       | (114                                | )          | (12                     | )          | 2,719 |   | 3,396 |   | (677 | ) | (20 | ) |
| Selling, general  & administrative expenses |       | 830                                  |       | 786                     |       | 44                                  |       | 6                       |       | 2,919 |   | 2,470 |   | 449 |   | 18 |   |
| Research &  development expenses            |       | 637                                  |       | 394                     |       | 243                                 |       | 62                      |       | 1,684 |   | 1,385 |   | 299 |   | 22 |   |
| Total operating  expenses                       |       | 1,467                                |       | 1,180                   |       | 287                                 |       | 24                      |       | 4,603 |   | 3,855 |   | 748 |   | 19 |   |
| Gain on sale of  manufacturing rights           |       | —                               |       | —                  |       | —                              |       | —                  |       | — |   | 1,432 |   | (1,432 | ) | (100 | ) |
| Income (loss)  from operations                  |       | (604                                 | )          | (203                    | )          | (401                                | )          | (198                    | )          | (1,884 | ) | 973 |   | (2,857 | ) | (294 | ) |
| Other income                                    |       | 105                                  |       | 123                     |       | (18                                 | )          | (15                     | )          | 336 |   | 310 |   | 26 |   | 8 |   |
| Net income  (loss)                              |       | (499                                 | )          | (80                     | )          | (419                                | )          | 524                     |       | (1,548 | ) | 1,283 |   | (2,831 | ) | (221 | ) |

 

***ProductSales***

 

Disposable TMR kit revenues, the largest component ofproduct sales in the three months ended September 30, 2007, decreased by$119,000, or 16%, as compared to the three months ended September 30, 2006. Domesticdisposable TMR kit revenues decreased $87,000 resulting from a lower volume ofkit shipments to Novadaq than to Edwards in the 2006 period as well asdecreased deferred kit revenue amortization. International disposable TMR kitrevenues decreased $32,000 in the three months ended September 30, 2007 ascompared to the three months ended September 30, 2006 due to a lower volume ofkit shipments to international customers.

 

In the nine months ended September 30, 2007,disposable TMR kit revenues decreased by $378,000, or 18%, as compared to thenine months ended September 30, 2006. Domestic disposable TMR kit revenuesdecreased $399,000 resulting from a lower volume of kit shipments to Novadaqthan to Edwards in the 2006 period. This decrease in TMR kit shipments toNovadaq was offset in part by a $20,000 increase in deferred kit revenueamortization. International disposable TMR kit revenues increased $1,000.

 

TMR laser revenues, the second largest component ofproduct sales in the three months ended September 30, 2007, decreased by$179,000, or 24%, as compared to the three months ended September 30, 2006. Thisdecrease resulted from (1) decreased revenue sharing earned under our TMRdistribution agreements and (2) a lower average selling price on new domestic

 

18

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TMR lasers.

 

In the nine months ended September 30, 2007, TMR laserrevenues decreased by $678,000, or 35%, as compared to the nine months endedSeptember 30, 2006.  International TMR laser revenues decreased $276,000due to the sale of two lasers to international customers in the nine monthsended September 30, 2006, whereas there were no international TMR laser salesin the nine months ended September 30, 2007. Domestic TMR laser revenues decreased $402,000, or 24%, primarily as aresult of (1) decreased revenue sharing earned under our TMR distributionagreements with Edwards and Novadaq and (2) a lower average selling price onnew TMR lasers.

 

Other product salesincreased $88,000, or 100%, and $343,000, or 162%, respectively, in the threeand nine months ended September 30, 2007 as compared to the three and ninemonths ended September 30, 2006.  Theseincreases were driven primarily by (1) new manufacturing contract assemblyproduct revenues, which we commenced as a new source of revenue during thefourth quarter of 2006, and (2) increased sales of new and refurbished surgicallaser tubes to a single OEM customer. We believe the addition of new contractassembly work will result in increased revenues in this category of productsales during the remaining quarter of 2007 as compared to what we realized inthis category in the corresponding quarter in 2006.

 

                Optiwave980 revenues to Edwards were $0 and $100,000 in the three and nine months endedSeptember 30, 2007, respectively, while they were $20,000 in the three and ninemonths ended September 30, 2006.  InDecember 2006, Edwards announced the discontinuation of the Optiwave 980, whichwe manufactured for Edwards under a supply agreement prior to its beingdiscontinued.  We do not expect togenerate any revenues from this product line in the future.

 

***Service Fee Revenues***

 

Servicefees decreased $6,000, or 2%, and $10,000, or 1%, respectively, in the threemonths and nine months ended September 30, 2007 as compared to the three andnine months ended September 30, 2006. The decreases are primarily related to decreases in internationalservice billings.

 

***Gross Profit***

 

Total gross profit was $863,000, or 65% of total revenues, in the threemonths ended September 30, 2007 as compared with gross profit of $977,000, or62% of total revenues, in the three months ended September 30, 2006.  The improved gross profit percentage isprimarily a result of both lower inventory obsolescence and periodmanufacturing expenses in the three months ended September 30, 2007 as comparedto the three months ended September 30, 2006. The decrease in gross profit dollars is due to (1) lower disposable TMRrevenues, (2) a decrease in revenue sharing earned under our U.S. TMRdistribution agreements with Edwards and Novadaq and (3) a lower averageselling price on new TMR lasers.  These decreases were offset in part byhigher gross profit dollars generated from (1) increased revenues from new andrefurbished surgical tubes and contract assembly services, (2) a decrease ininventory obsolescence expense and (3) lower period manufacturing expenses.

 

19

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Total gross profit was $2,719,000, or 57% of total revenues, in thenine months ended September 30, 2007 as compared with gross profit of$3,396,000, or 63% of total revenues, in the nine months ended September 30,2006.  The decrease in gross profitdollars is due to (1) lower disposable TMR revenues, (2) a decrease in revenuesharing earned under our U.S. TMR distribution agreements with Edwards andNovadaq, (3) lower international TMR laser revenue, and (4) a lower averageselling price on new domestic TMR lasers. Thesedecreases were offset in part by higher gross margin generated from (1)increased revenues from new and refurbished surgical tubes and contractassembly services, (2) a decrease in inventory obsolescence expense and (3)lower period manufacturing expenses.

 

***Selling, General and AdministrativeExpenses***

 

Selling, general andadministrative expenditures increased 6% and 18%, respectively, in the threeand nine months ended September 30, 2007 as compared to the three and ninemonths ended September 30, 2006.  Theseincreases are related to increased headcount and higher compensation expense, increasedoverall spending on sales and marketing activities related to RenalGuard, aswell as higher corporate and legal expenditures incurred in connection with (1)the transfer of the U.S. TMR distribution agreement and (2) RenalGuard clinicaltrial contracts.

 

***Research and Development Expenses***

 

Research and developmentexpenditures increased 62% and 22% in the three and nine months ended September30, 2007 as compared to the three and nine months ended September 30,2006.  These increases are primarily dueto increases in clinical trial expenditures for RenalGuard.  These increases were partly offset bydecreases in expenditures in connection with new product development costsrelated to RenalGuard.

 

We expect to continue toincur significant new research and development expenditures for the remainderof 2007 and future years.  Our near termdevelopment efforts are focused on performing clinical trials of our newestproduct initiative, RenalGuard, which should lead to increased research anddevelopment expenditures from what we incurred in the first nine months of 2007at least through 2009.

 

***Gain on the Sale of Manufacturing Rights***

 

In March 2006, we received$1,500,000 related to the sale our Optiwave 980 disposable manufacturing rightsto Edwards.  In conjunction with thistransaction, we wrote off certain production equipment and inventory andrecorded a net gain of $1,432,000 in the nine months ended September 30, 2006.

 

***Other Income***

 

The largest component ofother income consists of interest income earned on our cash, cash equivalentsand short-term investments. 

 

Interest income decreased$18,000 in the three months ended September 30, 2007 as compared to the threemonths ended September 30, 2006.  Thedecrease is primarily a result of lower investable cash balances in the threemonths ended September 30, 2007.  

 

Interest income increased$26,000 in the nine months ended September 30, 2007 as compared to the ninemonths ended September 30, 2006.  Theincrease is primarily a result of a higher average interest rate earned oninvestable cash balance during the nine months September 30, 2007.

 

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***Net Income (Loss)***

 

In the three months ended September 30, 2007, werecorded a net loss of $499,000 as compared to a net loss of $80,000 in thethree months ended September 30, 2006.  This increased net loss isprimarily a result of higher operating expenses and lower sales and grossmargin in the three months ended September 30, 2007 as compared to the three monthsended September 30, 2006.

 

In the nine months endedSeptember 30, 2006, we recorded a gain from the sale of our Optiwave 980disposable manufacturing rights to Edwards. This non-recurring gain as well as higher sales, gross margin and loweroperating expenses resulted in recorded net income of $1,283,000 in the ninemonths ended September 30, 2006 as compared to a net loss of $1,548,000 in thenine months ended September 30, 2007.

 

***Kit Shipments***

 

Although we have generallyviewed disposable kit shipments to end users as an important metric inevaluating our business, we believe that specific short-term factors notindicative of long-term trends negatively affected shipments of disposable kitsin 2007 as previously indicated above. Disposable kit shipments to end users were as follows:

 
| ** **                      | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|
| ** **                      | ** ** | **2007**                             | ** ** | **2006**                            | ** ** | **%  Increase  (Decrease)  Over  2006** | ** ** | **2007** | ** ** | **2006** | ** ** | **%  Increase  (Decrease) Over  2006** | ** ** |
|                            |       |                                 |       |                                |       |   |   |   |   |   |   |   |   |
| Domestic (by  U.S. Distributor) |       | 313                                  |       | 502                                 |       | (38 | ) | 1,194 |   | 1,530 |   | (22 | ) |
| International                   |       | 2                                    |       | 13                                  |       | (85 | ) | 32 |   | 38 |   | (16 | ) |
| Total                           |       | 315                                  |       | 515                                 |       | (39 | ) | 1,226 |   | 1,568 |   | (22 | ) |

 

In addition to the impact of factors previouslydiscussed that we believe affected kit shipments in the first nine months of2007, it is our belief that TMR kit shipments in recent years havelargely been affected by what we believe is an ongoing downward trend in thenumber of bypass surgeries being performed. We believe the proliferation ofinterventional cardiac procedures being performed, particularly with the use ofdrug eluting stents, is causing a delay in the number of patients beingreferred to cardiac surgeons for surgical treatment of their cardiovasculardisease. Because a significant number of the total TMR procedures performedeach year by cardiac surgeons are done in combination with bypass surgery, webelieve the growth in the number of TMR procedures may be being adverselyimpacted by this reduction in the number of bypass surgeries being performed.

 

**Liquidityand Capital Resources**

 

Cash, cash equivalents andshort-term investments totaled $8,712,000 as of September 30, 2007, a decreaseof $1,322,000 from $10,034,000 as of December 31, 2006.  We have no debt obligations. We believe thatour existing cash resources will meet our working capital requirements throughat least the next 12 months.

 

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Cash used for operatingactivities in the nine months ended September 30, 2007 was $1,191,000 due toour net loss, partially offset by favorable working capital changes, non-cashdepreciation and amortization and compensation related to stock options.  We used $153,000 for the purchase ofequipment.  Additional cash of $7,000resulted from the exercise of stock options and proceeds from our employeestock purchase plan and $15,000 was provided by the effect of exchange ratechanges.

 

Wewill be largely dependent on the future success of Novadaq’s sales andmarketing efforts in the U.S. to continue to increase the installed base of oursecond generation Heart Laser System, the HL2, and to substantially increaseTMR procedural volumes and revenues. Should the installed base of HL2 lasers orTMR procedural volume not increase sufficiently, our liquidity and capitalresources will be negatively impacted. Additionally, other unanticipated decreases in operating revenues orincreases in expenses or changes or delays in third-party reimbursement tohealthcare providers using our products may adversely impact our cash positionand require further cost reductions or the need to obtain additionalfinancing.  It is not certain that we,working with Novadaq and our international distributors, will be successful inachieving broad commercial acceptance of the Heart Laser Systems, or that wewill be able to operate profitably in the future on a consistent basis, if atall.

 

Some hospital customersprefer to acquire the Heart Laser Systems on a usage basis rather than as acapital equipment purchase.  We believethis is the result of limitations many hospitals currently have on acquiringexpensive capital equipment as well as competitive pressures in themarketplace.  A usage business model willresult in a longer recovery period for Novadaq to recoup its investment inlasers it will purchase from us in the future. This results in (1) a delay in our ability to receive additional sharedrevenue, if any, that we otherwise are entitled to receive under the terms ofour new distribution agreement with Novadaq and (2) a potential delay in thepurchase of new lasers by Novadaq if the installed base of lasers placed underusage contracts are under-performing and Novadaq chooses to re-deploy theselasers to other hospital sites in lieu of purchasing a new laser from us.  Our cash position and our potential need foradditional financing to fund operations will be dependent in part upon thenumber of hospitals that acquire Heart Laser Systems from Novadaq on a usagebasis and the number and frequency of TMR procedures performed by thesehospitals.

 

We believe we will incurlosses at least through 2009 as we increase our research and developmentspending in order to conduct the clinical trials that are necessary to obtainthe regulatory approval to market RenalGuard. We cannot be certain that future sales, if any, of RenalGuard willjustify the investments we plan to make. If we are unsuccessful in implementingour business strategy to introduce RenalGuard, or if the introduction ofRenalGuard takes longer or costs more than anticipated, our liquidity andcapital resources will be adversely affected and we may need to obtainadditional financing.

 

Therecan be no assurance that, should we require additional financing, suchfinancing will be available on terms and conditions acceptable to us.  Should additional financing not be availableon terms and conditions acceptable to us, additional actions may be requiredthat could adversely impact our ability to continue to realize assets andsatisfy liabilities in the normal course of business.  The consolidated financial statements setforth in this report do not include any adjustments to reflect the possiblefuture effects of these uncertainties.

 

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**Off-Balance Sheet Arrangements**

**               **None.

**Item 3.       Quantitativeand Qualitative Disclosures about Market Risk**

                A portion of ouroperations consists of sales activities in foreign jurisdictions.  We manufacture our products exclusively inthe U.S. and sell our products in the U.S. and abroad. As a result, ourfinancial results could be affected by factors such as changes in foreigncurrency exchange rates or weak economic conditions in the foreign markets inwhich we distribute our products.  Ouroperating results are exposed to changes in exchange rates between the U.S.dollar and foreign currencies, especially the Euro. When the U.S. dollarstrengthens against the Euro, the value of foreign sales decreases. When theU.S. dollar weakens, the functional currency amount of sales increases. Noassurance can be given that foreign currency fluctuations in the future willnot adversely affect our business, financial condition and results ofoperations, although at present we do not believe that our exposure is significant,as international sales represented only 1% and 4% of our consolidated salesduring the three and nine months ended September 30, 2007, respectively, and 8%of our consolidated sales in the year ended December 31, 2006. We do not hedgeany balance sheet exposures or intercompany balances against future movementsin foreign exchange rates.

                Our interest income and expense are sensitive tochanges in the general level of U.S. and foreign interest rates. In thisregard, changes in U.S. and foreign interest rates affect the interest earnedon our cash and cash equivalents.  We donot believe that a 10% change to the applicable interest rates would have amaterial impact on our future results of operations or cash flows.

## **Item 4.       Controls and Procedures**

                Ourmanagement, with the participation of our chief executive officer and chieffinancial officer, evaluated the effectiveness of our disclosure controls andprocedures as of September 30, 2007.  Theterm “disclosure controls and procedures”, as defined in Rules 13a-15(e) and15d-15(e) under the Exchange Act, means controls and other procedures of acompany that are designed to ensure that information required to be disclosedby a company in the reports that it files or submits under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms.  Disclosurecontrols and procedures include, without limitation, controls and proceduresdesigned to ensure that information required to be disclosed by a company inthe reports that it files or submits under the Exchange Act is accumulated andcommunicated to the company’s management, including its principal executive andprincipal financial officers, as appropriate to allow timely decisionsregarding required disclosure. Management recognizes that any controls and procedures, no matter howwell designed and operated, can provide only reasonable assurance of achievingtheir objectives and management necessarily applies its judgment in evaluatingthe cost-benefit relationship of possible controls and procedures.  Based on the evaluation of our disclosurecontrols and procedures as of September 30, 2007, our chief executive officerand chief financial officer concluded that, as of such date, our disclosurecontrols and procedures were effective at the reasonable assurance level.

                No change in ourinternal control over financial reporting (as defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) occurred during the fiscal quarter endedSeptember 30, 2007 

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that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

**Part II.  Other Information**

**Item 1A.      RiskFactors**

                The risks and uncertainties described below are notthe only risks we face.  Additional risksand uncertainties not presently known to us or currently deemed immaterial mayalso impair our business operations.  Ifany of the following risks actually occur, our financial condition andoperating results could be materially adversely affected.

***                Weexpect to incur significant operating losses in the near future.***

                We expect to incur net losses infuture quarters, at least through 2009, as we increase our research anddevelopment on clinical studies of RenalGuard. We cannot provide any assurancethat we will be successful with our business strategy, that RenalGuard willreceive FDA approval or commercial acceptance, or that we will ever return toprofitability.

***We are dependent on our new distributor of TMR products inthe U.S. to attempt to increase our TMR revenues.***

Novadaq’s salesorganization is responsible for selling a number of different products,including our TMR products.  We will belargely dependent on the future success of Novadaq’s sales and marketingefforts in the U.S. to increase the installed base of HL2 lasers and TMRprocedural volumes and revenues.  If ourrelationship with Novadaq does not progress as anticipated, or if Novadaq’ssales and marketing strategies fail to generate sales of our products in thefuture,******ourrevenue will decrease significantly and our business, financial condition andresults of operations will be seriously harmed.

***                Ourcompany is currently dependent on one principal customer.***

                Pursuant to the terms of our newTMR distribution agreement with Novadaq, Novadaq is our exclusive distributorfor our HL2 TMR laser and TMR kits in the United States.  As a result of this exclusive arrangement,Novadaq has become our principal customer, just as Edwards was our principalcustomer prior to the assignment of the distribution rights.

                Our U.S. distributor accountedfor 88% and 85% of total revenues in the three and nine months ended September30, 2007, respectively, and 88% in the year ended December 31, 2006.  As a result of this expected concentration ofsales with our U.S. distributor, we bear an increased financial risk of timelysales collection if, for any reason, Novadaq’s business condition shouldsuffer.

                ***Our company is currently dependent on one principalproduct line to generate revenues.***

                We currently sell one principalproduct line, the Heart Laser Systems, which accounts for the majority of ourtotal revenues.  Approximately 89% and86% of our revenues in the three and 

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nine months endedSeptember 30, 2007, respectively, and 95% in the year ended December 31, 2006,were derived from the sales and service of our Heart Laser Systems.  This absence of a diversified product linemeans that we are directly and materially impacted by changes in the market forHeart Laser Systems.

***                Our company is dependent oncertain suppliers.***

                Some of thecomponents for our Heart Laser Systems, most notably the power supply andcertain optics and fabricated parts for the HL2, are only available from onesupplier, and we have no assurance that we will be able to source any of oursole-sourced components from additional suppliers.  We are dependent upon our sole suppliers toperform their obligations in a timely manner. In the past, we have experienced delays in product delivery from oursole suppliers and, because we do not have an alternative supplier to producethese products for us, we have little leverage to enforce timely delivery. Anydelay in product delivery or other interruption in supply from these supplierscould prevent us from meeting our commercial demands for our products, whichcould have a material adverse effect on our business, financial condition andresults of operations.  Furthermore, wedo not require significant quantities of any components because we produce alimited number of our products each year. Our low-quantity needs may not generate substantial revenue for oursuppliers.  Therefore, it may bedifficult for us to continue our relationships with our current suppliers orestablish relationships with additional suppliers on commercially reasonableterms, if at all, and such difficulties may seriously harm our business,financial condition and results of operations.

***                Weare dependent upon our key personnel and will need to hire additional keypersonnel in the near future.***

                Our ability to operate ourbusiness successfully depends in significant part upon the retention andmotivation of certain key technical, regulatory, production and managerialpersonnel and consultants and our ongoing ability to hire and retain additionalqualified personnel in these areas. Competition for such personnel is intense,particularly in the Greater Boston area. We cannot be certain that we will beable to attract such personnel and the loss of any of our current key employeesor consultants could have a significant adverse impact on our business.

***                Ourcompany may be unable to raise needed funds.***

                As of September 30, 2007, we hadcash and cash equivalents totaling $8,712,000. Based on our current operatingplan, we anticipate that our existing capital resources should be sufficient tomeet our working capital requirements for at least the next 12 months; however,we may need to raise additional funds in the future.  We may not be able to raise additionalcapital upon satisfactory terms, or at all, and our business, financialcondition and results of operations could be materially and adverselyaffected.  To the extent that we raiseadditional capital by issuing equity or convertible securities, ownershipdilution to our shareholders will result. To the extent that we raise additional capital through the incurrence ofdebt, our activities may be restricted by the repayment obligations and otherrestrictive covenants related to the debt.

***                Inorder to compete effectively, our current and future products need to gaincommercial acceptance.***

                Our current TMR products maynever achieve widespread commercial acceptance. To be 

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successful, we andNovadaq need to:

•                  demonstrate to the medical community in general, and to heart surgeonsand cardiologists in particular, that TMR procedures are effective, relativelysafe and cost effective;

•                  support third-party efforts to document the medical processes by whichTMR procedures relieve angina;

•                  have more heart surgeons trained to perform TMR procedures using theHeart Laser Systems; and

•                  maintain and expand third-party reimbursement for the TMR procedure.

                To date, only a limited numberof heart surgeons have been trained in the use of TMR using the Heart LaserSystems.  We are dependent on Novadaq toexpand related marketing and training efforts in the U.S. for the use of ourproducts.

                The Heart Laser Systems have notyet received widespread commercial acceptance. We believe that concerns over the lack of a consensus view on the reasonor reasons why a TMR procedure relieves angina in patients who undergo theprocedure has limited demand for and use of the Heart Laser Systems. Untilthere is consensus, if ever, of the medical processes by which TMR proceduresrelieve angina, we believe some hospitals will delay the implementation of aTMR program.

                If we are unable to achievewidespread commercial acceptance of the Heart Laser Systems, our business,financial condition and results of operations will be materially and adverselyaffected.

***                Ournewest product, RenalGuard, is still undergoing development and we have onlyrecently begun to test it in a clinical setting as part of our initial pilotclinical study.***

***               ***We have only completed the firstgeneration product design for our RenalGuard System and we are testing thedevice in a clinical hospital setting as part of our pilot human clinicalstudy. We may need to make substantial modifications to the design, features orfunctions of our device in order for it to obtain FDA approval or meet customerexpectations. These changes may not be able to be completed in a timelyfashion, if at all. Should any such modifications prove to be significantlymore costly or time consuming to engineer than we estimate, our ability tobring this product to market may be severely and negatively impacted.

***                Ourplanned future clinical trials to study the safety and effectiveness ofRenalGuard in preventing contrast-induced nephropathy will take us asignificant amount of time to complete, if we can complete them at all, and theresults of these clinical trials may not show sufficient safety and efficacyfor us to either obtain FDA approval or otherwise be able to successfullymarket and sell the product.***

***               ***Our businessstrategy to grow our revenues and profitability is largely dependent on oursuccess in timely completion of our planned future clinical trials ofRenalGuard. We hope to be able to demonstrate through clinical trials thatRenalGuard is safe and effective in preventing CIN, a 

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form of acute renal failure caused by exposure tocontrast media for patients undergoing imaging procedures.

                We can provide no assurance that when studied inhumans, RenalGuard will be shown to be safe or effective in preventing CIN, orthat the degree of any positive safety and efficacy results will be sufficientto either obtain FDA approval or otherwise successfully market our product.Furthermore, the completion of our planned clinical trials is dependent upon manyfactors, some of which are not entirely within our control, including, but notlimited to, our ability to successfully recruit investigators, the availabilityof patients meeting the inclusion criteria of our clinical study, thecompetition for these particular study patients amongst other clinical trialsbeing conducted by other companies at these same study sites, the ability ofthe sites participating in our study to successfully enroll patients in ourtrial, and proper data gathering on the part of the investigating sites.

                Should our clinical trials takelonger than we expect, our competitive position relative to existingpreventative measures, or relative to new devices, drugs or therapies that maybe developed, could be seriously harmed and our ability to successfully fundthe completion of the trials and bring RenalGuard to market may be adverselyaffected.

***                We willneed to build a direct sales and marketing organization or otherwise enter intoone or more distribution arrangements in order to market our RenalGuard Systemif and when it is approved for sale.***

***               ***We currently do not have a direct salesforce. Instead, we market our existing TMR products through Novadaq in theUnited States and through independent distributors outside the U.S.  We do not plan to use Novadaq to market ourRenalGuard System if and when it becomes commercially available to customers.We will need to either build an internal direct sales and marketingorganization or find distribution partners in order to successfully market ourRenalGuard System.

                If we choose to build a direct sales force, we maynot be able to attract qualified individuals with the requisite training orexperience to sell our product. In addition, we would need to devotesubstantial management time instituting policies, procedures and controls tooversee and effectively manage this new part of our organization, which couldadversely impact our daily operations and would require us to investsignificant financial resources, the cost of which could be prohibitive.

                If we instead choose to pursue an indirectdistribution strategy, we may not be able to identify suitable distributionpartners with sufficient industry experience, brand recognition, sales capacityand willingness/ability to maximize sales. Further, we may not be able tonegotiate distribution agreements with terms and conditions that are acceptableto us, including ensuring that our product receives adequate sales force focusand attention.

***                Ourprimary competitor in TMR may obtain FDA approval to market a new device, theimpact of which is uncertain on the future adoption rate of TMR.***

                Our primary TMR competitor, CardioGenesis, hasattempted in the past and may attempt in the future to obtain FDA approval tomarket its “percutaneous” method of performing myocardial revascularization,previously known as PMR, and recently rebranded as PMC 

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(percutaneous myocardialchanneling), which would provide a less invasive method of creating channels inthe heart.  If PMC can be shown to be safe and effective and is approvedby the FDA, it would eliminate the need in certain patients to make an incisionin the chest, reducing costs and speeding recovery.  It is unclear what impact, if any, approvalof a PMC device would have on the future adoption rate for TMR procedures. IfPMC is approved, it could erode the potential TMR market, which would have amaterial adverse effect on our business, financial condition and results ofoperations.

***                Rapidtechnological changes in our industry could make our products obsolete.***

                Our industry is characterized byrapid technological change and intense competition.  New technologies and products and newindustry standards will develop at a rapid pace, which could make our current andfuture planned products obsolete. The advent of new devices and procedures andadvances in new drugs and genetic engineering are especially concerningcompetitive threats.  Our future successwill depend upon our ability to develop and introduce product enhancements toaddress the needs of our customers. Material delays in introducing product enhancements may cause customersto forego purchases of our products and purchase those of our competitors.

                Many potential competitors havesubstantially greater financial resources and are in a better financialposition to exploit marketing and research and development opportunities.

***                We mustreceive and maintain government clearances or approvals in order to market ourproducts.***

                Our products and ourmanufacturing activities are subject to extensive, rigorous and changingfederal and state regulation in the U.S. and to similar regulatory requirementsin other major international markets, including the European Union andJapan.  These regulations and regulatoryrequirements are broad in scope and govern, among other things:

•                  product design and development;

•                  product testing;

•                  product labeling;

•                  product storage;

•                  premarket clearance and approval;

•                  advertising and promotion; and

•                  product sales and distribution.

                Furthermore, regulatoryauthorities subject a marketed product, its manufacturer and the manufacturingfacilities to continual review and periodic inspections.  We are subject to ongoing FDA requirements,including required submissions of safety and other post-market information andreports, registration requirements, Quality Systems regulations, andrecordkeeping requirements. The FDA’s Quality Systems regulations includerequirements relating to quality 

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control andquality assurance, as well as the corresponding maintenance of records anddocumentation.  Depending on itsactivities, Novadaq may also be subject to certain requirements under the U.S.Food, Drug, and Cosmetic Act and the regulations promulgated thereunder, andstate laws and registration requirements covering the distribution of ourproducts. Regulatory agencies may change existing requirements or adopt newrequirements or policies that could affect our regulatory responsibilities orthe regulatory responsibilities of a distributor like Novadaq.  We may be slow to adapt or may not be able toadapt to these changes or new requirements.

                Later discovery of previouslyunknown problems with our products, manufacturing processes, or our failure tocomply with applicable regulatory requirements may result in enforcementactions by the FDA and other international regulatory authorities, including,but not limited to:

•                  warning letters;

•                  patient or physician notification;

•                  restrictions on our products or manufacturing processes;

•                  voluntary or mandatory recalls;

•                  product seizures;

•                  refusal to approve pending applications or supplements to approvedapplications that we submit;

•                  refusal to permit the import or export of our products;

•                  fines;

•                  injunctions;

•                  suspension or withdrawal of marketing approvals or clearances; and

•                  civil and criminal penalties.

                Should any of these enforcementactions occur, our business, financial condition and results of operationscould be materially and adversely affected.

                To date, we have received thefollowing regulatory approvals for our products:

***                HeartLaser Systems***

*                United States —*We received FDA approval to market theHL1 Heart Laser System in August 1998 and the HL2 Heart Laser System in January2001.  However, although we have receivedFDA approval, the FDA:

•                  has restricted the use of the Heart Laser Systems by not allowing us tomarket these 

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products to treatpatients whose condition is amenable to conventional treatments, such as heartbypass surgery, stenting and angioplasty; and

•                  could impose additional restrictions or reverse its ruling and prohibituse of the Heart Laser Systems at any time.

Inaddition, as a condition of our original FDA approval for our TMR products, wewere required by the FDA to perform a postmarket surveillance study. The FDArecently requested that we submit a PMA Postapproval Study report summarizingthis postmarket surveillance study. As part of this report, the FDA requested thatwe analyze and discuss the adverse event and mortality rates seen in thepostmarket study and compare these results to the premarket study which waspresented as part of our initial FDA PMA application. We filed thispostapproval study report with the FDA on February 28, 2007.

Becauseof the significant safety information collected in the postapproval study, andas the FDA has indicated it plans to do in other product areas, we believe thatthe FDA plans to present the results at a future meeting of the FDA CirculatorySystem Devices Advisory Panel and thereafter determine what, if any, actionsshould be taken with respect to our current Heart Laser Systems PMA.

*                Europe —*We received the CE Mark from the EuropeanUnion for the HL1 and HL2 in March 1995 and February 2001, respectively.  However:

•                  the European Union could impose additional restrictions or reverse itsruling and prohibit use of the Heart Laser Systems at any time; and

•                  France has prohibited, and other European Union countries could prohibitor restrict, use of the Heart Laser Systems.

*                Japan —*Our HL1 Heart Laser System receivedmarketing approval from the Japanese Ministry of Health, Labor and Welfare (“MHLW”)in May 2006. However, the MHLW could impose restrictions in the future orreverse its ruling and prohibit use of the Heart Laser Systems at any time.

                In addition, it is unclear whatimpact the introduction of the HL2 into the U.S. and other internationalmarkets will have on the ability of our Japanese distributor to market ourolder, first generation HL1 in Japan. Although our Japanese distributor hasindicated to us that it plans to seek MHLW approval in the future to market ournewer HL2, we can provide no assurance that the distributor will be successfulin obtaining the necessary approvals or how long it may take to secure therequired approvals.

***                RenalGuard***

***               ***We presently have no governmentalapprovals to market our RenalGuard System. We must receive either FDA approvalor clearance before we can market our product in the United States. We mustalso receive CE Mark approval before we can market our product in the EU. Othercountries may require their own approvals prior to our being able to market ourproduct in those countries.

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                The process of obtaining and maintaining regulatoryapprovals and clearances to market a medical device can be costly and timeconsuming, and we cannot predict when, if ever, such approvals or clearanceswill be granted. Pursuant to FDA regulations, unless exempt, the FDA permitscommercial distribution of a new medical device only after the device hasreceived 510(k) clearance or is the subject of an approved PMA application. TheFDA will clear marketing of a medical device through the 510(k) process only ifit is demonstrated that the new product is substantially equivalent to other510(k)-cleared products.

                At the present time we are not aware of any clearpredicates with substantially the same proposed indications for use which wouldenable us to conclude that RenalGuard is likely to be cleared by the FDA as a510(k) device. Therefore, we believe RenalGuard most likely will need to gothrough the PMA application process.

                Because the PMA application process is more costly,lengthy and uncertain than the 510(k) process and must be supported byextensive data, including data from preclinical studies and human clinicaltrials, we cannot predict when our product may eventually come to market.Should we be unable to obtain FDA or CE Mark approval for RenalGuard, or shouldthe approval process take longer than we anticipate, our future revenue growthprospects could be materially and adversely affected.

***                Changesin third party reimbursement for TMR procedures or our inability to obtainthird party reimbursement for RenalGuard could materially affect future demandfor our products.***

                Demand for medical devices is often affected bywhether third party reimbursement is available for the devices and relatedprocedures.  Currently Medicare coverageis provided for TMR when it is performed as a sole therapy treatment.  In addition, when two or more medicalprocedures are performed in combination with each other, Medicare rulesgenerally allow hospitals to bill for whichever of the two procedures carriesthe higher reimbursement amount. Therefore, in situations where sole therapyTMR reimbursement rates exceed that provided for bypass surgery alone, ifhospitals perform a combination procedure where both bypass surgery andadjunctive TMR are performed on a patient, the hospital is able to bill for thehigher TMR procedure reimbursement payment. In these instances, the doctor alsocan bill an additional amount for performing multiple procedures.

                Certain private insurance companies and healthmaintenance organizations also currently provide reimbursement for TMRprocedures performed with our products and physician reimbursement codes havebeen established for both surgical procedures.

                No assurance can be given, however, that these payerswill continue to reimburse healthcare providers who perform TMR proceduresusing our products now or in the future. Further, no assurance can be given that additional payers will reimbursehealthcare providers who perform TMR procedures using our products or thatreimbursement, if provided, will be timely or adequate.

                Should third party insurance reimbursement for TMRprocedures be reduced or eliminated in the future, our business, financialcondition and results of operations would be materially and adversely affected.

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                Furthermore, we know of no existing Medicare coverageor other third party reimbursement that would be available to either hospitalsor physicians that would help defray the additional cost that would result fromthe future purchase and/or use of our RenalGuard System. We also can provide noassurance that we will ever be able to obtain Medicare coverage or other thirdparty reimbursement for the use of RenalGuard, which could materially andadversely affect the potential future demand for this product.

                In addition, the market for our all our productscould be adversely affected by future legislation to reform the nation’shealthcare system or by changes in industry practices regarding reimbursementpolicies and procedures.

***                Securingintellectual property rights for our RenalGuard System is critical to ourfuture business plans, but may prove to be difficult or impossible for us toobtain.***

***               ***We have filed seven patent applicationsand have one provisional patent application pending at the United States patentoffice related to our RenalGuard System, RenalGuard Therapy and otherintellectual property in the general field of preventing contrast-inducednephropathy and acute renal failure. Securing patent protection over ourintellectual property ideas in this field is, we believe, critical to our plansto successfully differentiate and market our RenalGuard System and grow ourfuture revenues. We can provide no assurance, however, that we will besuccessful in securing any patent protection for our intellectual propertyideas in this chosen field or that our efforts to obtain patent protection willnot prove more difficult, and therefore more costly, than we are otherwiseexpecting. Furthermore, even if we are successful in securing patent protectionfor some or all of our intellectual property ideas in this field, we cannotpredict when in the future any such potential patents may be issued, how strongsuch patent protection will prove to be, or whether these patents will beissued in a timely enough fashion to afford us any commercially meaningfuladvantage in marketing our RenalGuard System against other potentiallycompetitive devices.

***                Assertingand defending intellectual property rights may impact our results ofoperations.***

                In our industry, competitorsoften assert intellectual property infringement claims against oneanother.  The success of our businessdepends on our ability to successfully defend our intellectual property.  Future litigation may have a material impacton our financial condition even if we are successful in marketing our products.We may not be successful in defending or asserting our intellectual propertyrights.

                An adverse outcome in anylitigation or interference proceeding could subject us to significant liabilitiesto third parties and require us to cease using the technology that is at issueor to license the technology from third parties.  In addition, a finding that any of ourintellectual property is invalid could allow our competitors to more easily andcost-effectively compete with us.  Thus,an unfavorable outcome in any patent litigation or interference proceedingcould have a material adverse effect on our business, financial condition orresults of operations.

                The cost to us of any patentlitigation or interference proceeding could be substantial.  Uncertainties resulting from the initiationand continuation of patent litigation or interference proceedings could have amaterial adverse effect on our ability to compete in the marketplace.  Patent litigation and interferenceproceedings may also absorb significant management time.

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***                We maybe subject to product liability lawsuits; our insurance may not be sufficientto cover damages.***

                We may be subject to productliability claims.  Such claims may absorbsignificant management time and could degrade our reputation and themarketability of our products.  Ifproduct liability claims are made with respect to our products, we may need torecall the implicated product, which could have a material adverse effect onour business, financial condition and results of operations. In addition,although we maintain product liability insurance, we cannot be sure that ourinsurance will be adequate to cover potential product liability lawsuits. Ourinsurance is expensive and in the future may not be available on acceptableterms, if at all. If a successful product liability claim or series of claimsexceeds our insurance coverage, it could have a material adverse effect on ourbusiness, financial condition and results of operations.

***                We aresubject to risks associated with international operations.***

                A portion of our product salesis generated from operations outside of the U.S.  Establishing, maintaining and expanding internationalsales can be expensive.  Managing andoverseeing foreign operations are difficult and products may not receive marketacceptance.  Risks of doing businessoutside the U.S. include, but are not limited to, the following: agreements maybe difficult to enforce and receivables difficult to collect through a foreigncountry’s legal system; foreign customers may have longer payment cycles;foreign countries may impose additional withholding taxes or otherwise tax ourforeign income, impose tariffs or adopt other restrictions on foreign trade;U.S. export licenses may be difficult to obtain; and the protection ofintellectual property rights in foreign countries may be more difficult toenforce.  There can be no assurance thatour international business will grow or that any of the foregoing risks willnot result in a material adverse effect on our business or results ofoperations.

***                Wewill soon have to comply with requirements regarding internal control overfinancial reporting.***

                Pursuant to Section 404 of theSarbanes-Oxley Act of 2002, beginning with our fiscal year ending December 31,2007, our management will be required to provide a report on the effectivenessof our internal control over financial reporting.  We are working to perform this evaluation inorder to comply with these requirements. Compliance with these requirements is expected to be expensive andtime-consuming.  If we fail to timelycomplete this evaluation, we could be subject to regulatory action and publicconfidence in us could be adversely affected and our stock price coulddecline.  In addition, any failure toimplement required new or improved controls, or difficulties encountered intheir implementation, could harm our operating results or cause us to fail tomeet our reporting obligations.

***                Becausewe are incorporated in Canada, you may not be able to enforce judgments againstus and our Canadian directors.***

                Under Canadian law, you may notbe able to enforce a judgment issued by courts in the U.S. against us or ourCanadian directors. The status of the law in Canada is unclear as to whether aU.S. citizen can enforce a judgment from a U.S. court in Canada for violationsof U.S. securities laws. A separate suit may need to be brought directly inCanada.

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***                Ourstock price has historically fluctuated and may continue to fluctuatesignificantly in the future which may result in losses for our investors.***

***               ***Our stock price has been and may continueto be volatile. Some of the factors that can affect our stock price are:

•                  the announcement of new products, services or technological innovationsby us or our competitors;

•                  actual or anticipated quarterly increases or decreases in revenue,gross margin or earnings, and changes in our business, operations or prospects;

•                  speculation or actual news announcements in the media or industry tradejournals about our company, our products, the TMR or CIN prevention proceduresor changes in reimbursement policies by Medicare and/or private insurance companies;

•                  announcements relating to strategic relationships or mergers;

•                  conditions or trends in the medical device industry;

•                  changes in the economic performance or market valuations of othermedical device companies; and

•                  general market conditions or domestic or international macroeconomicand geopolitical factors unrelated to our performance.

***                Themarket price of our stock may fall if shareholders sell their stock.***

                Certain current shareholders, including Edwards, holdlarge amounts of our stock, which they could sell in the public market fromtime to time.  Sales of a substantialnumber of shares of our common stock within a short period of time could causeour stock price to fall.  In addition,the sale of these shares could impair our ability to raise capital through thesale of additional stock.

**Item 6.           Exhibits**
| 31.1   |   | Certification of Chief  Executive Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                   |
| 31.2   |   | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a) or Rule 15d-14(a) of the  Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|   |   |                                                                                                                                                                                                   |
| 32.1   |   | Certifications pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                             |

 

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**SIGNATURES**

                Pursuant to the requirements of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.
|                    | PLC SYSTEMS INC. |
|-------------------------|------------------|
|                    |             |
| Date: November 14, 2007 | By:              | /s/ James G. Thomasch |
|                    |             | James G. Thomasch |
|                    |             | Chief Financial Officer  (Principal Financial Officer and Chief  Accounting Officer) |

 

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**EXHIBIT INDEX**
| **Exhibit  Number** | ** ** | **Description of  Document**                                                                                                                                                                      |
|---------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1                |       | Certification of Chief  Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities  Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                                                              |
| 31.2                |       | Certification of Chief  Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) of the Securities  Exchange Act of 1934, as adopted pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002. |
|                |       |                                                                                                                                                                                              |
| 32.1                |       | Certifications pursuant  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                        |

 

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